Index funds are group investments in top performing stocks, which tend to reflect the overall trends in the market. Funds in the U.S. include The S&P 500, the Dow, and the Nasdaq 100. These funds are “stock groupings” made up of the strongest performing companies in the United States. Companies which are represented in these indexes include Coca-Cola, American Express, and Johnson and Johnson.

An index fund will typically outperform most other types of stock investments, including the top actively managed funds. Only 20% of actively managed funds out-perform these top index funds. The benefits include ease of use, better performance, and low maintenance. The cons include the expense of the fund, minimum investment per fund, and the risks that come along with any stock investment.

Pro: Ease of Investment

The stocks represented in index funds are a snapshot that represents the overall activity of the market. For example, if Coca-Cola accounts for around 1.5% of the total value of the market, your portfolio would allocate 1.5% to Coca-Cola shares. This type of investing, is simple to understand and does not require substantial research. These funds are easy for a novice investor to understand and get started in the market.

Index funds are sometimes referred to as “dumb money”, because they require little research or maintenance. The performance is usually superior when compared to “actively managed funds” and are usually less expensive. Even the most well-educated (and well paid) fund managers fail to out perform these basic funds.

By making a purchase in an index fund, you are buying a share in the market’s top performers. This basic strategy has a proven track record. The risk is low and over the long term the returns are consistent.

Con: Cost of The Fund

Fund managers charge the investor a certain percentage to buy into the fund. The “expense” of index funds are usually low and can range from .05% to .4%. Funds called “no-load funds”, are free of commission to shareholders. Many “100% no-load funds”, outperform funds that have a front end or back end commission. This increased profit, is often due to a lack of commission taken by the fund manager.

Some funds are more expensive to buy into than others. They can require larger minimum investments, which start at $10,000 or more. Some funds, on the other hand, do not require a large minimum buy, and can be started for as little as a $100 investment.

Part of smart index investing is choosing a fund with a minimum buy-in that fits within budget, has a low expense ratio, and a selection of funds that fit your criteria.

Do Not Become Complacent

Index fund investing takes minimal work and skill, but can provide solid returns. This may lead some investors to become lax, and skip the proper research. All stock investments contain risk, even low risk ventures need to be properly evaluated. Many experts also recommend diversifying to include indexes in foreign countries.

Not All Index Funds Are Good Investments

There are many different types of index funds which do not reflect the market as a whole. For example, certain funds may take shares in only the top financial sectors. This would not represent the market as a whole, so there may be additional risk. In a poor economy, an index of financial companies like banks, may perform poorly. Most indexer’s recommend a fund like the S&P 500 which takes shares in the top 500 companies of the “entire” market.

Long Term Gains

Index funds are smart way to grow your money in the long term. They should be part of any conservative strategy, but there is still room for higher risk, short term stocks. Higher risk investments with larger gains still have room in your portfolio. A well diversified stock portfolio should contain a mix of investment types, techniques, and risks. If you are able to diversify correctly, certain strategies will perform when others are lacking.

(Ross manages the website Great Credit Score. The site was set up to provide free information to consumers about credit repair, debt, investments, and the overall state of the economy.)

This post was written by yours truly, Jon Elder. My mission is to help you succeed in your personal finance life. Join me on the journey to financial freedom! You can subscribe through RSS FEEDor EMAIL updates. You can also find me on TWITTER
and FACEBOOK
. Happy investing 🙂

This post was written by yours truly, Jon Elder. My mission is to help you succeed in your personal finance life. Join me on the journey to financial freedom! You can subscribe through RSS FEEDor EMAIL updates. You can also find me on TWITTER
and FACEBOOK
. Happy investing 🙂